Family trusts becoming more important than ever

As the changes to superannuation rules creep closer, accountants should advice their clients on the benefits of having a family trust as well as an SMSF.

Family trusts continue to be an important investment vehicle that can be used for a range of different purposes, and we see no sign that this will change any time soon, especially with all of the recent tightening of the superannuation rules.

Our advice to most families is that in addition to building up their superannuation balances, they should also set up a family trust to hold much of their family’s investment assets.

A family trust may hold a range of different assets such as:

Investment properties;

Investment portfolio (comprising various asset classes);

For SME business owners, shares in the business operating entities;

Business premises used by the operating entities; and

Personal use assets such as holiday homes and boats (but not the family home).

Unlike superannuation funds, there are no restrictions on the amounts that can be contributed to a family trust and no specific compliance requirements other than documenting annual distributions to beneficiaries, preparing annual financial accounts and lodging tax returns.

This makes a family trust the perfect companion to a self-managed superannuation fund. As a first step, a couple looking to build up their family wealth would each typically maximise their concessional superannuation contributions each year.

Where excess cash is available, the family should also consider making non-concessional contributions to their SMSF and/or loaning some of the excess cash to their family trust, which would then be used by the trust to acquire the desired investments.

It’s not, however, a question of having either a SMSF or a family trust. We generally recommend using both entities under the family’s overall savings/investment strategy.

Some of the key advantages of using a family trust as an investment vehicle include:

Very strong asset protection from creditors (but not necessarily in family law matters);

Total flexibility when distributing income and capital, which can be very tax effective and allows for changing family circumstances from year to year and over time;

Can improve ability to use small business capital gains tax (CGT) concessions and, unlike an investment company, allows individual beneficiaries to receive the 50 per cent CGT discount; and

The family trust falls outside a person’s deceased estate so control of the trust can be passed down through different generations regardless of the terms of any wills (subject to trusts having a maximum life, typically 80 years in most states except South Australia).

One of the main disadvantages from a tax viewpoint is that losses from negatively geared investments remain trapped inside the trust and cannot be distributed to family members. Any losses can, however, easily be carried forward and offset against future trust income.

In the short term, it may still be worthwhile holding negatively geared investments in individual names, but once the family starts building its wealth, especially if there are no borrowings or at least where they are positively geared, a family trust structure is usually preferable.

As for the impact of the recent superannuation changes due to take effect from 1 July 2017, there are two key points that will push even more of the family’s wealth into a family trust.

Firstly, the reduction in the annual non-concessional contributions cap to $100,000 and the concessional cap to $25,000, means that a couple will be able to contribute only $250,000 between them each year to their SMSF. Any additional savings that they wish to invest will need to use another investment vehicle, and this is where the family trust may be useful.

Secondly, the $1.6 million cap on the amount of assets that can be allocated in a super fund to pay a tax-free pension in retirement may provide an incentive to hold at least a portion of the excess investment assets outside of super, and again a family is likely to be a useful vehicle for this purpose.

While individuals will need to consider the reduced caps when planning when, and by how much, they will start increasing their contributions to super. In the meantime, a family trust is also a good place in which to start saving and investing, knowing that the funds will be more accessible if/when they are needed rather than locked away until retirement.

As the individuals get closer to retirement, however, they will usually start to move more of their investment assets from the family trust or their own names into an SMSF.

Finally, once the individuals are in retirement and drawing down a tax-free retirement pension, any funds in excess of their immediate needs can be parked in the family trust and either accessed by them as needed or accumulated to be passed on to their children and grandchildren as they wish, with total flexibility and without any immediate tax implications. In contrast, any amounts that remain in the SMSF at the death of the second spouse will need to be paid out to their beneficiaries, and there will be tax consequences of the death benefit paid.